Cost benefit may see banks line up for preference shares float

Banks may make a beeline to raise capital through the issue of preference shares as there is a huge cost advantage involved vis-a-vis a public issue.

The finance minister yesterday announced that banks will be allowed to raise capital through issuance of preference shares which was hitherto not permitted.

This is to help them shore up their capital base to take care of higher capital requirement on account of Basel II norms. The Banking Regulation Act 1949 will be amended to ensure this.

A preference issue is cheaper than a public issue. A bank can save on the front of book running and merchant banking fees, advertising & publicity, stationery, courier charges and postage in the case of preference shares all of which are a must in a public issue.

The servicing cost in a preference share issue is also lower since it involves fewer number of investors.

Dividends apart, the cost of a public issue with much fanfare typically works out to 3-5 per cent of the size of the issue. In the case of a subdued preference shares issue, the cost would be less than 1 per cent of the issue size.

The expenditure for preference shares comes in the form of lead manager fees (if at all), preparation of offer document and listing.

Several banks like Bank of Baroda, Bank of India, Allahabad Bank, Oriental Bank of Commerce, Syndicate Bank, Vijaya Bank and Indian Overseas Bank which have lined up second public issues, may just be tempted to change their plans and go in for an issue of preference shares, said an analyst.

Bankers are awaiting detailed guidelines from the Reserve Bank of India (RBI) and the Securities and Exchange Board of India (Sebi) on the issue.

They expect a cap on how much a bank can raise through the route.

The preference shares route also offers a solution to the PSU banks many of which are grappling with the issue of lowering headroom in raising tier I capital.

Soon banks will be able to issue preference shares to the government and help keep the promoter's holding over the mandated level of 51 per cent.

Preference shares by definition give a fixed dividend to the investor which is decided on a negotiated basis between the issuer and the investor.

The dividend can be denied only if the issuer does not make profits.